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Get it, Keep it, Use it: How to Invest at Every Age

In our recent Investment Outlook issue, I did a short story on age-based investment tips for 2009 focusing on investors 25 to 35; 35 to 55; and 55 to 75. Although no one is named in the story, I interviewed dozens of financial advisers for my piece. I received a tons of great advice I couldn’t include, and that’s why I’m posting tips from different investment experts here.

This advice comes from Leon C. LaBrecque, who has a slew of smart tips for investors. He also has a slew of titles: JD, CPA, CFP, CFA, and managing partner of LJPR, LLC, an independent fee-based wealth management firm in Troy, Mich. LJPR specializes in providing retirement and financial solutions to individuals. He has a lot to say on the subject of age-based investing, but it does it so eloquently, I didn’t want to trim it much.

25-35: Get It: You’re in accumulation phase. Here what matters is the amount you can save. Market fluctuations aren’t too important to you; they’re sales along the way. So the key thing is to get money into the pile and keep saving.

Pay Yourself First: Remember to pay yourself first. Everyone seems to set a budget on saving what’s left after taxes and expenses. Look around where you live: someone makes less than you and is just as happy. Set aside 10% of you gross pay for yourself in your 401(k) or Roth IRA. When you get a raise, split it with your 401(k) or Roth: you get half, it gets half.

Equities Are King: Every long-term study shows that equities (stocks of companies) will outperform other asset classes. However, individual stocks can clobber you if you don’t own enough. In addition, you need to spend time and energy researching those stocks (time that could be spent on more fruitful activities, like making money). Look into equity mutual funds. Watch the fees. Look for good long term funds with low expenses. Index funds are a good starting point.

Go Global: The world is flat. You need to participate in the whole global economic growth. So make sure you not only invest in US equities, but in international equities as well.

Small Can Get Big: Through history, small stocks have outperformed big stocks. See if you can name a big company that wasn’t once a small company. Add a small index fund into your mix.

Your Recipe: For someone accumulating, you can weather a lot of market motion. You could have about 20-30% of your portfolio in bonds or fixed income, 25-40% in large US equities, 10-20% in small equities, and 15-30% in International equities. You could add a small taste of emerging markets, like 5-10%, or 5-10 in a commodity-based fund.

35-55: Keep It: At this phase, you’re in a preservation mode. Here you should be getting toward ‘critical mass’, where your investments make more than you contribute. For example, suppose you have a 401(k) plan with $250,000. You make 8% on your investments, which gives you an addition of $20,000. The maximum you can contribute to the plan (if you’re 49 or under) is $16,500. You money is adding more than you are. So here, volatility becomes an issue: you want more consistent return and safer return.

Become a Value Shopper: At this phase, investors should start looking at the growth/value split. Value investing is a method that looks to finding the relatively lower priced stock in a market. For example, value indexes will look at a group of stock, like the S&P 500, and split them into the lower relative priced group and higher relative priced group. History shows that value outperforms in the long run, while growth will dramatically outperform for shorter periods. Value asset classes can be large, mid or small cap.

More Airbags: In the preservation phase, you want more regular income and don’t want to rely on capital appreciation. Here, you want to add more bonds into the portfolio. You bonds should look like your equities, globally diversified. Watch out for putting too many eggs in one basket, like high-yield. High yield bonds are of companies that have lower credit ratings (junk bonds).

Stay Global: Staying global with your investments is important in the preservation phase. Make sure you have a mix that encompasses US and international equities.

Watch the Middle: A lot of investors look at stocks as large-cap or small-cap. There is an asset class of mid-cap stocks which has a good feature for the preservation investor: these are stocks that are not yet giant, but have survived long enough to quit being small. Historically, the mid cap asset class has done quite well versus large caps, and the risk is lower than the small cap asset class.

Season to Taste: A critical discipline for this part of your life is to rebalance your investments. As history has shown us, markets can be very volatile. Rebalancing allows you to automate your selection. Market goes down? A rebalance takes money from your cash and bonds (which have stayed relatively up) and buys into equities (which are down). Market goes up? The rebalance lets you take some profits off the table and put them in safe assets. You don’t need to get carried away; an annual rebalance should give you most of the benefits of rebalancing.

Stash Some Cash: On top of your retirement portfolios, you’d want to accumulate 3-6 months expenses in a decent insured money market account. Of course, you never want to have any significant credit card balance. Use them and pay them off.

Kiddos? Starting the family? The college costs for your kiddos will be staggering. Attack the problems as soon as possible. While the tots are in diapers, set up a §529 plan for them. Pretend you’re sending them to a nice private school. Persuade grandma and grandpa and whoever likes them that a tax-free college fund is a great investment tool.

Your Recipe: For a 35-55 year old in preservation mode, for your retirement portfolio: 5% in cash (for rebalancing), 25-35% in a mix of US and global bonds, 15-25% in US large equities (maybe about half of that in a value type fund), 10-15% in mid cap US (again maybe half in value), and 10-15% in small cap equities (ditto on the value). 15-25% in international equities. You may want to keep a portion (like 5% or so) in emerging markets and real estate.

55-75: Use It: At this point in life, you’re considering using retirement funds to either support or to supplement your lifestyle. In this phase, volatility becomes a problem, but you have to remember that your major enemy is not the market, but losing purchasing power.

Income is King: Investors tend to look at their net worth as the key indicator of how they are doing. Instead, you should focus on your income and how well it is doing. Make sure you have an ample position in bonds and stocks that pay dividends. Be sure that your portfolio is generating enough income for your needs. Value equities, and bonds, as well as real estate, are the key generators of income.

Ladders: For part of your portfolio, consider the old simple notion of a ‘ladder ‘of bonds or CDs. This is where you have a series of bonds or CDs maturing at different dates. For a retiree who wants income, you might have five years of distributions in a ladder of bonds maturing in each year of the next five years (or every six months or whatever you like). This ladder should count as part of your total allocation, but allows you to weather five years of storms at a time. In addition, as you use one step of the ladder, you set up another one as you rebalance your portfolio.

Watch Your Mandatory Distributions: When you attain the age of 70 , you have to start taking money out of your IRA. The required distribution starts at around 4%. Many retirees wait until they’ve achieved 70 to take the distribution. This throws them into a higher tax bracket, plus has the notion of providing a 70 year with a lot of income. Consider taking a smaller distribution earlier, like 3 or 4%. Then when the minimum distribution starts, you’ll already be taking money out of the IRA, plus you will have reduced the balance. Remember, someone is going to buy a trip to Florida with your IRA; it may as well be you.

Rebalance: Rebalancing is a time-proven technique for reducing risk in a portfolio. In a distribution portfolio, you can rebalance your equities to take profits or seize opportunities. If you choose to ‘ladder’ a portion of CDs or bonds, your rebalance will re-set the ladder to the later rungs. In addition, you can re-set your allocation slightly more conservative at different points, like every five years or so. You might be 60% in equities from 55-60, and 55% in equities from 60-65, and so forth.

Cash: You should consider having one-year’s expenses in a quality money market account, or a split of 6 months in a money market and 6 months expenses in a 6-month CD. When it gets more than one-year, invest it in an income producing investment.

Recipe: At this juncture, you want a significant portion of the portfolio in short-term income investments, with a concentration on income. Figure up to 5 years distributions in short term bonds or a bond ladder, and a total of 35-50% in bonds or income investments. 10-15% in equities, with a focus on dividend paying investments (value) and 10% each in mid and small cap (concentrations value). Have 10-15% in international. You may want to avoid the exotic investments but could consider 5-10% in real estate: they aren’t making any more of it.

75 plus: Pass It. At this juncture in your life, you want and probably need income and potentially, you may want to pass on something to your heirs.

Annuities: One problem in planning is creating a guaranteed stream of income. One way to accomplish a lifetime income stream is to buy an immediate annuity. This can be particularly attractive for investors who have gains in variable annuities that they’ve purchased in the distant past that have appreciated. You can roll a variable annuity into an immediate annuity with no current tax consequences and pay the taxes as you receive the annuity payments.

The annuity will pay for your life (or both of you, if you choose).

Banks and CDs. It makes sense to have one to two years worth of funds in insured bank account and CDs. A good idea is to have about 3 months expenses in an insured money market, and have 6 months expenses in a six month CD, 1 year CD and 18 month CD. You can add on a 24 month CD as well. Shop the banks and mind the total FDIC insurance amount.

Recipe: Believe it or not, the safest mix of investments historically is not a 100% bond portfolio, but a 20% equity and 80% bond portfolio. Older retirees could still get some appreciation on their investments though the equities, while using the bonds to generate income. It also makes sense in a retirement portfolio to have the required minimum distributions set aside for a few years in specific bonds or short term bond funds.

Appreciated Stocks or Funds: If you have some IBM you bought in 1983, or some GE you inherited form you mom and dad and there’s a large capital gain, you may want to hang onto it. Under the current law, property that passes on death receives a step-up in basis. So if you paid $3,000 for some IBM and its now worth $20,000, if you sell it, you’ll pay capital gains tax. If you keep it and pass it on to your heirs, they will receive it at the value at the date of your death. No capital gains.